The SEC has been poking around valuations for a while.
First it was from the chaos of the 2008 financial crisis. The sudden
illiquidity and drop in prices left many scratching their heads about the
proper valuations for their assets.
That was the main charge against the Bear
Stearns hedge fund managers. The Justice Department and the SEC brought
parallel criminal and civil charges against former Bear Stearns executives
Ralph Cioffi and Matthew Tannin in 2008. They were accused of lying to
investors about the health of their hedge funds. The problem was that they were
holding mostly complex securities backed by subprime mortgages that were hard
Valuations are always difficult with private equity funds
because by definition most of the assets are private securities, with little or
no market to determine price. The difficulty is offset by the result of the
valuation. That is, there is very little. It's rare that a private equity fund
limited partner/investor can redeem its interest. Private equity limited
partners commit their capital long term to the fund since the fund makes long
term investments that take many years to realize.
A private equity fund investor can be happy that the fund
is performing well or be disappointed that the the fund is under-performing
based on valuations. Either way, they are largely stuck as investor. But that's
okay because the investors true returns come when the investment is realized,
not when there is a valuation.
There is some opportunity for malfeasance. Marketing
would be the weak spot. A private equity fund manager might be inclined to
overstate valuations on unrealized investments to make their track record look
better when raising money for a new fund.
Federal regulators and the Massachusetts attorney general
are investigating whether a private equity fund that was part of Oppenheimer
Holdings Inc. overstated the value of one of its holdings. The result would be
to make it look like the fund was performing better than it actually was.
to the Wall Street Journal, the fund manager place a value of $9.3 million
on an investment. Some other trading on that investment indicated a value of
only $2 million, and an intermediary placed the value at $6 million. According
to the Boston Globe, the result was to set the interim performance of the
fund at 38 percent instead of a loss of 6.3 percent. I assume that the
investigators are claiming that the fund manager used those inflated valuations
to lure investors.
Valuations have clearly been a target for securities
regulators for several years. The SEC
sweep letter sent to several private equity firms was just a continuation
of this investigative objective.
Part of the business model of private equity is that they
are able to better value companies and re-structure them for success. That
means that valuations of their underlying assets are going to vary from those
of other firms and appraisers.
The key is documenting your approach and then documenting
that you followed that approach.
additional commentary on developments in compliance and ethics, visit Compliance Building,
a blog hosted by Doug Cornelius.
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